FT interview: Big blues

When Ginni Rometty addresses restless shareholders on Wednesday at IBM’s annual investor day, it will be with the practised air of someone used to handling the regular upheavals of the industry.

“This company reinvents itself every decade. It’s doing it again,” she said this week during an interview at the US tech company’s headquarters in a wooded suburb north of New York. “I do believe this industry is going through very important change and it will reorder itself. We will be a leader out the other end, as we have been every other time.”

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Talk of business transformation comes easily to the first woman – and ninth CEO – to run Big Blue in its century-long history. A smooth saleswoman with a background in advisory work, she made her name building the division that sells business services to customers facing digital disruption.

Now it is IBM that is being buffeted by the winds of change. “She’s the perfect person to make sure they don’t just do more of the same,” says Jeffrey Sonnenfeld, a professor at the Yale School of Management.

Talking about the need for sweeping change is one thing but pulling it off is quite another. The approach that served IBM well for nearly two decades, making it a model for many companies in the IT world, is facing its first serious test.

The rise of the cloud – a term that refers to the centralisation of computing power in the data centres of companies such as Amazon and Google, which then sell services over the internet to their customers – threatens all IT suppliers that have made a living selling and helping to run large corporate and government systems.

The IBM that Ms Rometty inherited two years ago is nowhere near the basket case it was in the early 1990s, when a near-death experience led to the shake-up that put it on its present course. But it is showing the strain. After badly falling short of revenue forecasts, its stock has all but missed the 50 per cent rally in major US stock indices since the start of 2012.

Striking proof of how things are changing came late last year when the US Central Intelligence Agency handed a $600m data centre contract to an unlikely supplier: internet retailer Amazon. The sight of a government agency whose name is a byword for information security hiring a company that made its name on the consumer internet may well turn other customers’ heads, says Toni Sacconaghi, a computer industry analyst at Sanford C Bernstein. That “could call into question IBM’s role as the pre-eminent partner” for corporate IT departments, he adds.

“You can never be fired for buying IBM” has long been a mantra for risk-averse IT managers. But these days, according to Steve Milunovich, a tech analyst at UBS in New York, customers can sometimes be heard using a new refrain that should send a chill down IBM’s spine: “No one gets fired for buying Amazon.”

The core of IBM’s business over the past decade lies in what outsider Lou Gerstner did to revive it from a financial crisis after he was brought in to run the company in 1993. At the time, its mainframe computing empire was threatened by the proliferation of low-cost PCs and servers – the so-called “client/server” era that eventually exploded with the rise of the internet.

Before Steve Jobs returned to save Apple, Mr Gerstner’s resuscitation of IBM was the most striking revival of a tech company facing the threat of irrelevance. Ms Rometty, who is known to turn to him for advice, credits Mr Gerstner with the realisation that the rise of the internet caused much greater complexity for IT managers. His response: to greatly expand IBM’s software and services divisions to meet this new demand.

Mr Gerstner’s successor, Sam Palmisano, put his own stamp on the company with a further overhaul to reorganise its operations along more global lines. That was partly code for shifting tens of thousands of jobs offshore as IBM struggled to compete with the rise of low-cost Indian outsourcing companies.

The result was a mighty and highly reliable earnings machine. According to Ms Rometty, more than half of IBM’s revenues, along with more than 60 per cent of its profits, are tied to long-term contracts such as technology outsourcing and software maintenance and support. That has brought stability to its finances.

For more than a decade, IBM has raised its earnings per share by 11 per cent a year, even as its revenues have risen only 2 per cent. In 2011, that record was sufficient to attract the attentions of Warren Buffett, the investor, who had previously steered clear of the tech industry. Mr Buffett’s near-$11bn investment, for more than 6 per cent of the stock, has made him IBM’s biggest shareholder.

As it turns out, he would have done better to buy index funds. IBM shares have underperformed the wider market since then, as revenues have slipped and Wall Street has worried that large parts of its business are threatened by the cloud.

Ms Rometty flatly rejects the idea advanced by some on Wall Street that IBM is weighed down by a “bad portfolio” of permanently damaged businesses. But she admits substantial parts of its operations are contracting.

“Don’t confuse slow and declining with not needed, unnecessary, not being reinvented,” she says. Some 70 per cent of the data held by the world’s biggest companies run on IBM systems, even if the relentlessly deflationary forces of IT have pushed down the costs for customers. The goal is to raise profit margins continually on these businesses even if they are shrinking, she says.

In the race to deal with such pressures, Ms Rometty has accelerated IBM’s periodic disposals of businesses with declining profit margins as it tries to reposition itself in the most profitable parts of tech. “At $100bn [in revenues], you constantly have to reinvent yourself,” she says.

Yet while this has helped to keep IBM on track to hit its five-year earnings targets, Wall Street’s confidence in the foundations of its approach has been shaken. Revenues and cash flow fell last year as computer sales slumped and customers in countries such as China and Brazil cut back.

That has left investors reassessing the durability of earnings improvements that had come to seem almost automatic. Most of the earnings-per-share gains of recent years have come from cost-cutting or from buying back stock, with relatively little from moving into new, high-margin businesses, says Mr Sacconaghi.

Critics go further, contending that the relentless cost-cutting to hit earnings targets has damaged IBM’s business. It has been “death by a thousand cuts”, says Bob Djurdjevic, a former IBM executive and IT analyst.

Such accusations exasperate Ms Rometty. “I don’t know what else I would do – what did I not do?” she says. Pointing to IBM’s spending on research and development, she adds: “Our investment level at over 6 per cent of revenues is fantastic and has been unwavering.”

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Big shifts in technology, however, often leave previous winners stranded. That is not because they did not perform well enough against their own plans, but because they could not compete with a new, disruptive way of doing business.

Investors worry, for instance, that customers will no longer need to spend as much on big outsourcing deals with IBM, or even buying high-value consulting services. Instead, rather than maintaining their own IT systems, they may prefer to pay the likes of Amazon to use its data centres, or buy subscriptions from a company such as Salesforce.com to access its software online.

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Nor will it be easy to challenge such new competitors head-on. With massive scale and a willingness to operate on very narrow profit margins, Amazon has become a fearsome rival in so-called “public cloud” services.

Ms Rometty says such fears are overstated. She says big customers who buy from IBM will not be satisfied with what she claims are less robust services from internet companies not used to meeting the needs of companies like banks or airlines.

She suggests that solving complexity will remain a big selling point for IBM as big companies try to integrate existing technology with the new cloud services. But she is far too practised a saleswoman to brag about making money out of her customers’ pain. “It’s all of our jobs to mask complexity in everything we do.”

And she has hung her hopes squarely on big data – the idea that helping customers collect, store and analyse data is set to become IBM’s most important function. For all companies, she says, “information – really, analytics – is going to be the basis of competitive advantage”.

The contraction of recent quarters has brought a heightened sense of urgency, and Ms Rometty’s impatience is showing. In recent months, that has meant ploughing into new, faster-growing markets, at times in ways that jar with IBM’s more established business methods.

One of these has involved an aggressive move into the public cloud business against Amazon – a reversal of the company’s position that its large corporate clients would not become big users of these services. A second has been to press ahead faster with an advanced question-and-answer computer called Watson.

Even if they turn out to be big markets in the long run, they will not solve Ms Rometty’s immediate problems. Launching speedboats is of limited use to a corporate supertanker.

Despite the recent agitation on Wall Street, IBM remains highly valued in relation to some of its rivals. “This is still not authentically a crisis, it’s still a moment of reflection,” says Mr Sonnenfeld. He credits Ms Rometty with “stirring the pot” in much the way Mr Gerstner did. While she may attract less attention than her mentor, he adds: “The internal revolutionaries tend to be more effective.”

Ms Rometty herself pays tribute to an IBM culture that she says has served the company well over the long term, even as she presses for faster action from its 400,000 workers. Asked what she is doing to shake things up, she stresses a more responsive approach to the company – “a constant change, test, change, test [in] real time”. She adds: “I think all businesses are going to move into that: experiment, learn, try.”

The effects of cloud computing, though long predicted, are only just starting to be felt across the IT landscape. IBM’s latest CEO will have to demonstrate all her skills in business transformation if she wants to avoid a rerun of the crisis that hit the company once before.

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Computer brains: A challenge as tough as a cure for cancer

It is three years since IBM held an eye-catching public demonstration of its most advanced computing “brain”.

Known as Watson, after the company’s founder, the system won against the top human contestants on the US quiz game Jeopardy. In the process, it demonstrated an ability to master natural language, one of the hardest problems in computing. The breakthrough raises the possibility of “smart” digital assistants and new ways of interacting with computers.

But Ms Rometty has only this year thrown Big Blue’s full weight behind commercialising the technology, with the promise of a $1bn investment in a business unit for “cognitive computing” – a new field in which Watson is the acknowledged leader.

In a symbolic gesture, it will be housed in a landmark office in the heart of Silicon Alley, New York’s start-up district.

Asked why it has taken so long, she retorts: “Watson is right on target. But we’re not doing something simple – we are solving cancer.”

The computing “trick” lies in a highly complex form of pattern recognition. The system looks for correlations that point to the “right” answer.

IBM’s first application of Watson was in healthcare, with an ambitious partnership with Memorial Sloan Kettering hospital to diagnose lung cancer. That was followed by broader applications in healthcare, for instance in drug discovery and in helping judge whether claims should be covered under particular insurance policies.

In finance, companies such as Royal Bank of Canada and USAA are working on advisory services capable of “bringing financial advice to the masses”, says Ms Rometty.

IBM recently announced a plan to open the technology to uses such as helping ecommerce companies devise better ways for customers to interact with their services.

The CEO says the service will be priced on the basis of the value of its answers to users, with progress against cancer being worth more than tackling ecommerce problems, though she refuses to be specific.

“It is commercialising on plan,” says Ms Rometty, who describes Watson as one of her long-term bets for IBM. “People say: three years, why aren’t you faster? OK – how many decades have people been solving cancer?”